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BR Blog: Reform of pension tax relief

It is widely expected that George Osborne will use his March Budget to do away with higher rate tax relief on pension contributions in favour of a single flat rate for all.

This raises the prospect of many high earners paying more tax in retirement than the tax they have saved on contributions made while working.

Generally it is accepted that people do not save enough for their retirement. Research suggests that tax relief on pension contributions is no incentive to the lower paid to save, but those on higher income save because there is merit in doing so. This group mianly saves to a pension because of the relief; take the relief away and this group may simply save through other means. We shall see.

In short, society is not getting a very good return on its tax relief investment and it spends a lot: £34.3bn in 2013/14. Of course, the Treasury gets to tax pension income in retirement, but the £13.1bn pension tax receipts in the same year leave a £21.2bn gap in the country’s finances.

It is felt that pension saving can be better marketed if it is described as the government topping up personal contributions: ‘3 for the price of 2’ or ‘buy 3, get 1 free’, dropping any notion of 33.33% or 25% tax relief that these ‘offers’ represent.

Various bodies calculate that the Chancellor could move to a 30% flat rate at much the same cost. However, dropping to 25% would save the Treasury £6bn a year.

It is not obvious how a flat rate of relief will be managed, especially where employer contributions are concerned. Charging higher/additional rate tax payers 10% to 20% tax on their employer’s pension contributions via PAYE is most likely.

The reduction in tax relief need not prove a disincentive to higher rate tax payers to save to a pension: as long as the rate of tax you pay on your income in retirement will be less than the flat rate relief received on contributions, there remains a tax break. However, someone receiving 25%/30% relief on contributions, only to be paying 40% income tax in retirement might feel it would be better to take the money up front at a lower tax rate. Anyone facing this prospect might like to pay any additional contributions ahead of the Budget on 16 March.